You can count the number of big biotechs that pay dividends without even using all of your fingers. Two of the best dividends belong to Amgen (AMGN -0.54%) and Gilead Sciences (GILD -0.18%). Amgen's dividend currently yields nearly 2.7%, while Gilead's yield stands right at 4%.
Neither company has had any problems whatsoever in the past funding its dividend program. But that doesn't mean the future won't hold any bumps in the road. Which of these big biotechs has a safer dividend?
What the numbers say
One of the most important metrics to look at when evaluating the health of a given company's dividend is the payout ratio. This number provides a quick assessment of what percentage of a company's earnings are being used to fund dividends.
Amgen's payout ratio of 43.6% indicates that the biotech should be able to easily keep its dividends flowing without breaking a sweat. On the other hand, Gilead's payout ratio of 116% appears to be more concerning. No company can pay out more in dividends than it makes in profits for very long.
But before we immediately give the safer dividend prize to Amgen, let's dive deeper into Gilead's financial position. The company reported a net loss of $1.17 billion in the third quarter and shelled out $2.4 billion in dividend payments during the period. This performance weighed heavily on Gilead's payout ratio.
There's more to the story, though. Gilead's Q3 loss resulted from the company's $3.92 billion upfront payment that was part of its expanded collaboration agreement with Galapagos. Before the paper loss in the third quarter, Gilead's payout ratio was around 52%. Although that's a little higher than Amgen's number, it's still quite healthy.
Looking to the future
An even more critical factor to consider is how strong Amgen's and Gilead's cash flows are. A company with solid cash flow can fund a dividend program even if its earnings are low.
Amgen's operating cash flow over the last 12 months was $9.8 billion with a free cash flow of $6.4 billion. Gilead's operating cash flow during the same period was $8.9 billion with a free cash flow of $3.3 billion. While Amgen pays out a little more than Gilead does in dividends each quarter ($2.6 billion, compared to $2.4 billion in Q3), its stronger cash flow appears to give it more flexibility in funding future dividends.
But cash flows can decline over time. Amgen faces significant competition for several of its top-selling drugs. Sales continue to plunge for Neulasta and Sensipar, especially. Meanwhile, the worst days for Gilead's hepatitis C virus (HCV) franchise appear to be in the past, setting the stage for the company to deliver stronger cash flow going forward with its HIV drugs and a potential winner in immunology with filgotinib.
Still, though, Wall Street analysts project that Amgen will increase its earnings by an average of nearly 8% annually over the next five years. The biotech's newer products such as migraine drug Aimovig and immunology drug Otezla (which Amgen picked up with Bristol-Myers Squibb's acquisition of Celgene) should fuel revenue and earnings growth. Analysts think Gilead will return to earnings growth over the next five years but will be able to increase earnings by less than 2% annually.
The safer dividend
My view is that both Amgen and Gilead Sciences are solid dividend stocks. I don't think either company will run into problems paying dividends. But if I had to pick only one of these stocks based solely on how safe its dividend is, I'd have to go with Amgen because of its lower payout ratio and stronger cash flow.
I think the jury is still out on earnings growth, though. My hunch is that Gilead will beat analysts' earnings growth projections if it wins regulatory approvals for filgotinib and its HCV franchise sales stabilize more than they've done so far. I also expect Gilead to continue offering a higher yield than Amgen does, even if Amgen dramatically increases its dividend (which I think is very likely).
But a higher dividend yield doesn't translate to a safer dividend. I believe Amgen still has the edge on that front.